The National Pension System, commonly known as NPS, allows individuals to build a retirement corpus while receiving specified income-tax deductions. The tax benefit depends on who makes the contribution, the tax regime selected by the individual and the applicable percentage and monetary limits.

Separate provisions apply to:

• An employee's own NPS contribution
• A self-employed individual's NPS contribution
• An additional personal contribution of up to ₹50,000
• An employer's contribution to an employee's NPS account

Most personal NPS deductions are available only under the old tax regime. However, the deduction for an employer's contribution to NPS is available under both the old and new tax regimes, subject to the applicable limits.

NPS tax deductions at a glance

1. Employee's own NPS contribution

An employee contributing to an eligible NPS Tier I account may claim a deduction under section 80CCD(1) of the Income-tax Act, 1961, provided the employee has selected the old tax regime.

The deduction is restricted to the lower of:

• The amount actually contributed by the employee; or
• 10% of the employee's salary.

For this purpose, salary generally includes basic salary and dearness allowance where the terms of employment provide that the dearness allowance forms part of retirement benefits. Eligible commission calculated as a fixed percentage of turnover may also be considered.

Other allowances, bonuses and perquisites are not automatically included in the salary used for calculating the percentage limit.

Combined ₹1.5 lakh limit under section 80CCE

The total deduction under sections 80C, 80CCC and 80CCD(1) cannot exceed ₹1,50,000 for the financial year.

This combined limit may include eligible amounts such as:

• Employee provident fund contributions
• Public provident fund contributions
• Life insurance premiums
• Eligible tuition fees
• Principal repayment of an eligible housing loan
• The contribution claimed under section 80CCD(1)

Treatment under the new tax regime

An employee cannot claim a deduction for their personal NPS contribution under the new tax regime. The new regime disallows most deductions under Chapter VI-A, including deductions for personal NPS contributions.

The employer's NPS contribution is treated differently and may continue to qualify under the new regime.

2. Additional NPS deduction of up to ₹50,000

An individual selecting the old tax regime may claim an additional deduction of up to ₹50,000 under section 80CCD(1B).

This deduction is over and above the combined ₹1.5 lakh ceiling under section 80CCE.

The deduction is restricted to the lower of:

• The qualifying NPS contribution not already claimed elsewhere; or
• ₹50,000.

The same contribution cannot be claimed twice. An amount claimed under section 80CCD(1) cannot again be claimed under section 80CCD(1B).

The additional ₹50,000 deduction is not available under the new tax regime.

3. NPS deduction for a self-employed individual

A self-employed individual contributing to an eligible NPS Tier I account may claim a deduction under section 80CCD(1), provided the individual selects the old tax regime.

The deduction is restricted to the lower of:

• The amount actually contributed
• 20% of the individual's gross total income

This deduction is included within the combined ₹1.5 lakh ceiling under section 80CCE.

A self-employed individual may also claim the additional deduction of up to ₹50,000 under section 80CCD(1B), provided the same contribution has not already been claimed under section 80CCD(1).

Personal NPS deductions under sections 80CCD(1) and 80CCD(1B) are not available to a self-employed individual selecting the new tax regime.

4. Employer's contribution to an employee's NPS account

An employer may contribute to an employee's eligible NPS account in addition to the contribution made by the employee.

The employee may claim a deduction for the employer's contribution under section 80CCD(2).

Unlike an employee's personal contribution, the employer-contribution deduction:

• Does not form part of the ₹1.5 lakh limit under section 80CCE
• Is separate from the additional ₹50,000 deduction
• Is available under both the old and new tax regimes
• Is restricted by the applicable percentage of salary

Central and State Government employees

For an employee of the Central Government or a State Government, the deductible employer contribution is restricted to the lower of:

• The amount actually contributed by the employer
• 14% of salary

The 14% limit applies under both the old and new tax regimes.

Employees of other employers under the old tax regime

For an employee of a private-sector or other non-government employer selecting the old tax regime, the deduction is restricted to the lower of:

• The actual employer contribution; or
• 10% of salary.

Employees of other employers under the new tax regime

For a non-government employee selecting the new tax regime, the deduction is restricted to the lower of:

• The actual employer contribution; or
• 14% of salary.

Employee deduction and employer business deduction are different

The deduction claimed by an employee for the employer's NPS contribution should not be confused with the business expenditure deduction available to the employer.

An eligible employer may claim its NPS contribution as a business expenditure under section 36(1)(iva) of the Income-tax Act, 1961, subject to the applicable conditions and a limit of 14% of the employee's salary.

Therefore, in the case of a non-government employee under the old tax regime:

• The employer may qualify for a business deduction up to 14% of salary; but
• The employee's deduction under section 80CCD(2) may be restricted to 10% of salary.

Combined ₹7.5 lakh limit for employer contributions

A separate perquisite-tax rule applies where an employer contributes to one or more of the following funds:

• A recognised provident fund;
• An eligible NPS account; and
• An approved superannuation fund.

Where the employer's aggregate contribution to these three funds exceeds ₹7,50,000 during a financial year, the excess contribution is taxable as a perquisite in the employee's hands.

Annual accretion attributable to the taxable excess, calculated in the prescribed manner, may also be taxable as a perquisite.

Comparison under the Income-tax Act, 1961 and Income-tax Act, 2025

The Income-tax Act, 2025 applies from 1 April 2026. It reorganises and renumbers the NPS provisions, while substantially continuing the main deduction and withdrawal rules.

Returns for FY 2025-26 and AY 2026-27 continue to be governed by the Income-tax Act, 1961. The Income-tax Act, 2025 applies from tax year 2026-27 onward, subject to its commencement, repeal and saving provisions.

Practical examples

Example 1: Employee under the old tax regime

Assume that an employee has:

• Salary for section 80CCD purposes: ₹10,00,000;
• Personal NPS contribution: ₹1,50,000; and
• Other eligible section 80C investments: ₹50,000.

The percentage limit under section 80CCD(1) is:

10% of ₹10,00,000 = ₹1,00,000

The employee may claim:

• ₹50,000 for other eligible section 80C investments;
• ₹1,00,000 for NPS under section 80CCD(1); and
• ₹50,000 for NPS under section 80CCD(1B).

The total deduction is ₹2,00,000, comprising ₹1,50,000 within the section 80CCE ceiling and an additional ₹50,000 under section 80CCD(1B).

Example 2: Self-employed individual under the old tax regime

Assume that a self-employed individual has:

• Gross total income: ₹8,00,000; and
• NPS contribution: ₹2,00,000.

The percentage limit is:

20% of ₹8,00,000 = ₹1,60,000

The individual may claim:

• Up to ₹1,50,000 under section 80CCD(1), subject to the combined section 80CCE ceiling; and
• The remaining ₹50,000 under section 80CCD(1B).

The total deduction may therefore reach ₹2,00,000, provided the individual has made sufficient eligible contributions and has not used the ₹1.5 lakh limit for other deductions.

Example 3: Private-sector employer contribution under the new tax regime

Assume that:

• Salary for NPS purposes is ₹12,00,000;
• The employee works for a private-sector employer;
• The employee selects the new tax regime; and
• The employer contributes ₹1,68,000 to NPS.

The applicable limit is:

14% of ₹12,00,000 = ₹1,68,000

The employee may claim the entire ₹1,68,000 under section 80CCD(2), even though deductions for the employee's own section 80C and NPS contributions are not available under the new regime.

If the same employee selected the old tax regime, the employee's deduction would ordinarily be restricted to:

10% of ₹12,00,000 = ₹1,20,000

Taxation of NPS withdrawals

The deduction allowed when an individual contributes to NPS does not mean that every amount received from NPS is exempt. Separate rules apply to lump-sum withdrawals, annuity purchases, pension receipts, partial withdrawals and amounts received following the subscriber's death.

1. Lump-sum withdrawal on normal exit

On closure of an NPS account or opting out of the scheme, up to 60% of the total amount payable is exempt from income tax.

Under the Income-tax Act, 1961, the exemption is provided by section 10(12A). Under the Income-tax Act, 2025, the corresponding exemption is contained in item 6 of Schedule II.

Under the general NPS exit framework, a subscriber may withdraw up to 60% as a lump sum on normal exit. The balance is generally required to be used to purchase an annuity, subject to the applicable PFRDA regulations and small-corpus provisions.

2. Amount used to purchase an annuity

The amount applied to purchase an annuity is not taxed merely because the annuity is purchased.

However, the pension or annuity payments subsequently received are taxable in the recipient's hands in the year of receipt at the applicable tax rates.

This treatment is continued under the corresponding NPS provisions of the Income-tax Act, 2025.

3. Partial withdrawal

A qualifying partial withdrawal from NPS is exempt up to 25% of the subscriber's own contributions.

The 25% exemption is calculated with reference to the subscriber's own contribution and not the total value of the NPS account.

The withdrawal must also satisfy the applicable NPS conditions relating to matters such as:

• The minimum subscription period;
• The permitted purpose of withdrawal;
• The maximum number of withdrawals; and
• Other conditions prescribed under the NPS regulations.

Under the Income-tax Act, 1961, the exemption is provided by section 10(12B). Under the Income-tax Act, 2025, it is contained in item 4 of Schedule III.

4. Premature exit

Under the general PFRDA framework, a subscriber exiting NPS prematurely may ordinarily withdraw a limited portion as a lump sum and may be required to use the remaining corpus to purchase an annuity.

The exact amount that may be withdrawn and the annuity requirement depend on the applicable PFRDA exit regulations and any small-corpus relaxation.

Periodic annuity payments remain taxable when received.

5. Amount received following the subscriber's death

Where the NPS corpus is received by a nominee or legal heir following the subscriber's death, the amount is not treated as the nominee's income under the relevant NPS taxation provision.

This treatment is substantially continued under the Income-tax Act, 2025. The nominee or legal heir must comply with the applicable NPS death-claim and withdrawal procedure.

6. Full withdrawal permitted under small-corpus rules

PFRDA regulations may permit full withdrawal where the NPS corpus is below a specified limit.

Documents to retain for claiming NPS benefits

Taxpayers should retain the following documents:

• Permanent Retirement Account Number or PRAN
• NPS transaction statement
• Contribution receipts or payment confirmations
• Form 16 and salary statements
• Salary breakup showing basic salary and eligible dearness allowance
• Details separating employee and employer contributions
• NPS exit or withdrawal statement
• Annuity purchase documents
• Pension or annuity certificates showing amounts received

The contribution reported in the income-tax return should agree with Form 16, salary records, bank records and the NPS transaction statement.

Common mistakes to avoid

Considering the ₹50,000 deduction part of the ₹1.5 lakh limit

The deduction under section 80CCD(1B) is additional to the ₹1.5 lakh combined ceiling under section 80CCE.

Claiming the same NPS contribution twice

A contribution claimed under section 80CCD(1) cannot again be claimed under section 80CCD(1B).

Claiming personal NPS contributions under the new regime

Personal contributions made by an employee or a self-employed individual are not deductible under the new regime. Only the specified employer contribution continues to qualify.

Using the employee's total CTC for the percentage calculation

The 10% or 14% limit is calculated using the statutory meaning of salary. It is not necessarily calculated on total CTC, gross salary or total taxable earnings.

Confusing the employee and employer deduction limits

The business deduction available to an employer and the deduction available to an employee under section 80CCD(2) are separate provisions and may have different limits.

Ignoring the combined ₹7.5 lakh perquisite ceiling

Employer contributions may satisfy the percentage limit but may still result in a taxable perquisite where the combined employer contribution to the specified retirement funds exceeds ₹7.5 lakh.

Assuming every NPS withdrawal is tax-free

The normal lump-sum exemption is subject to the statutory limit. Annuity payments are taxable when received, and partial withdrawals must satisfy the prescribed conditions.

Key takeaways

• Employee and self-employed NPS deductions are generally available only under the old tax regime.
• An employee's personal contribution is subject to 10% of salary.
• A self-employed individual's contribution is subject to 20% of gross total income.
• The deduction under section 80CCD(1) forms part of the combined ₹1.5 lakh limit under section 80CCE.
• An additional deduction of up to ₹50,000 may be claimed under section 80CCD(1B).
• Employer contributions remain deductible under both tax regimes.
• The employer-contribution limit is 14% for Central and State Government employees.
• For other employees, the limit is generally 10% under the old regime and 14% under the new regime.
• The combined ₹7.5 lakh employer-contribution perquisite ceiling must be checked separately.
• Up to 60% of the NPS corpus is generally exempt on closure or exit.
• Eligible partial withdrawals are exempt up to 25% of the subscriber's own contributions.
• Pension and annuity payments are taxable when received.

Conclusion

NPS tax benefits are divided among personal contributions, additional contributions and employer contributions. Each category has separate percentage limits, monetary limits and tax-regime conditions.

For FY 2025-26 and AY 2026-27, taxpayers must apply the provisions of the Income-tax Act, 1961. For tax year 2026-27 onward, the corresponding provisions of the Income-tax Act, 2025 apply.

Before claiming an NPS deduction, taxpayers should identify who made the contribution, confirm the tax regime selected, calculate the applicable salary or income percentage and ensure that the same contribution has not been claimed under more than one provision.

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